Criticism: The procedures do not
work because the institutional balance is too complicated

Background

132. As summarised in our introduction (see above,
paragraphs 58-60), the Stability and Growth Pact came under severe
strain last year when the Council did not endorse the Commission's
recommendation to issue an early warning to Germany and Portugal.
As explained above, this decision was widely interpreted as undermining
the credibility of the Pact.

Box 6 The Early-Warning Mechanism: Regulation (EC) No
1466/97

The Council monitors the implementation of stability and convergence programmes "with a view to identifying actual or expected 'significant divergences' of budget positions from the medium-term objective or the adjustment path towards it" (Article 6(1)). The Council's decisions are based on assessments made by the Commission and the Economic and Financial Committee.

If, on the basis of these assessments, the Council identifies such a significant divergence, it sends a recommendation to the Member State concerned "with a view to giving an early warning in order to prevent the occurrence of an excessive deficit" (Article 6(2)).

This Council adopts its recommendation "to take prompt corrective measures" by qualified majority (including the Member State concerned) on the basis of a Commission recommendation following the procedure outlined in Article 99(4) of the Treaty.

The SGP does not define what constitutes a 'significant divergence' from budgetary targets or in any other way define the conditions under which the early-warning mechanism is to be activated.

133. If a country receives an early warning of
an excessive deficit and following this warning the country's
deficit does not rise above 3 %, that is the end of the procedure.
There are no other steps unless the deficit goes up further and
breaches the reference value, in which case the next procedure
(i.e., the excessive deficit procedure) may be activated. The
early-warning mechanism does not itself lead to the excessive
deficit procedure (EDP) and the possibility of sanctions. The
decision to implement the EDP is taken separately from any warning,
and the EDP can be applied even if a warning has not been sent
to the Member State, as was clearly shown in the cases of Germany
and Portugal.

134. In theory, the early-warning mechanism outlined
in the box represents a three-stage process:

1. the Commission assesses the situation and activates
the early warning mechanism, by making a recommendation to the
Council;

2. the Council takes a decision (after consulting
the EPC and based on the Commission recommendation) whether or
not a significant divergence from budgetary targets has occurred
and whether to issue an early warning; and

3. the Member State concerned responds and announces
appropriate policy measures.

135. The Commission, however, pointed out that
these steps were re-ordered in the case of Germany and Portugal,
where the Council effectively reversed steps 2 and 3, with the
two Member States concerned announcing corrective action before
the Council decided whether to issue an early warning (Public
Finances in EMU2002, European Economy No.3,
2002, p.51).

The Commission's proposal

136. The Commission proposed that it should be
given the authority, without recourse to a Council vote, to issue
an initial early warning directly to any Member State at risk
of running an excessive deficit or significantly departing from
the recommendations drawn up under the BEPGs.[61]
The Commission suggested that this could lead to "more direct
and timely signalling of budgetary problems". Such a proposal
would greatly simplify the system.

137. The Commission further proposed that:

"the Member State concerned should be excluded
from any vote on issuing warnings. The Treaty already makes provision
for such exclusion where the Council has to issue a formal notice
to a Member State about correcting an excessive deficitbut
this detail has been omitted from the voting arrangements on issuing
warnings. By definition, the Member State concerned will generally
be opposed to any such warning. Excluding it from the vote would
therefore prevent a situation in which it was both judge and defendant."
(op. cit.)

138. These proposals would require a change to
the Treaty, which can only be achieved by unanimous agreement
between the Member States. The Commission therefore submitted
these proposals to the Convention on the Future of Europe, which
is considering what Treaty changes are necessary to prepare for
the enlargement of the EU in 2004. The conclusions of the Convention
will be forwarded to the IGC that is scheduled to take place in
the autumn.

Evidence

139. Many of our witnesses supported the Commission's
proposal, saying the current arrangements were not working, because,
as Professor Buiter put it, the Council did not have "the
political capacity to deliver and enforce a judgment against a
member country". There was a fear that political tradeoffs
could be made in the Council. In the Council's system of peer
review, Member States did not want to sit in judgement on a country
that might be judging them subsequently. Therefore, the Pact should
move to a system of Commission review. Sending an initial early
warning to Member States was part of the surveillance and monitoring
process, as such it was preventative-as indicated by being covered
under Regulation No 1466/97.[62]
These witnesses supported strengthening of the Commission's role
in the surveillance process, because they saw the process of monitoring
Member States' compliance with the Pact to be the proper role
of the Commission, as the guardian of the Treaties. Furthermore,
the decision to send an early warnings should be based wholly
on facts; it was not a political decision (QQ 10, 16, 91;
pp. 27, 70).

140. The Government, unsurprisingly, spoke out
strongly against this proposal. They claimed that, although there
had been problems when the issue of early warnings first arose,
that is, with Germany and Portugal at the beginning of 2002, this
was no longer the case; the Council was now functioning much more
effectively. This was evidenced by the Council's decision to send
an early warning to France (as decided at the Ecofin Council meeting
on 21 January 2003, see above paragraphs 63-64). The Government
also argued against the proposal on the grounds of national sovereignty.
They said it was "much better for Member States together
to decide what action [was] appropriate on the basis of strong
evidence from the Commission" (Q 196).

141. The TUC was the only other witness to oppose
this proposal, because, it said, the Commission did not have the
political legitimacy to issue the warnings. The warnings would
only be seen by Member States to have legitimacy if they came
through the Council. If warnings came directly from the Commission,
Member States would be less likely to pay such heed to them (Q
219).

142. To counter this problem of legitimacy, Begg
suggested that the judgement of the Commission could be subject
to an independent panel of experts, who would 'audit' the Commission's
analyses. This body could take a purely analytic view of the budgetary
position of the Member State and establish whether or not the
Commission had judged correctly that there was a risk of an excessive
deficit. If the panel found this to be the case, it would endorse
the Commission's opinion, giving the decision more legitimacy
(QQ 108, 110).

62
For the distinction between the two Regulations that form the
core of the Stability and Growth Pact and the corresponding distinction
between the preventative side of the Pact, which involves surveillance
and the early-warning procedure, and the deterrent side of the
Pact, which involves sanctions and the excessive deficit procedure,
see above, paragraphs 7-16. Back